Free Market Economy - Essay Example

?The term free market economy mainly means a system where land and capital are privately owned and the buyers and sellers are solely responsible for all economic decisions. The free market economy is usually associated with a pure capitalist system where prices influence the allocation of goods and services. In this kind of market, importance is placed on the freedom of the consumer and the worker, and the firm itself. The fact that a free market economy operates automatically is one of its major advantages. Moreover, when firms, consumers and workers pursue their own self interest through buying and selling in competitive markets, it helps in minimizing the central economic problem of scarcity, by encouraging the efficient use of resources (Lipsey 2003). In an actual scenario, however, markets fail to achieve maximum efficiency in the allocation of scarce resources resulting in inequality and unfavorable externalities therefore governments feel it necessary to intervene thus, in practice, perfect free market economies do not exist. Even in countries like USA, Germany and France, which are considered to be practicing free market to a great extent, there are many areas that are in government’s control. For example, in USA, there are laws proposed to verify illegal trade practices. They also have a government department called the FDA (Food and Drug Administration) that ensures all consumer products that are taken in to the body are toxic free. There are number of reasons as to why a free market ascends level of inequality and inefficiency in the economy. Firstly, a perfectly performing price system, as the case in a free market, does not provide for the issue of an ethical income distribution. In such a system, the limited supplies of goods and services are rationed out to those who can afford it. In other words, the scarce resources are usually diverted to the production of luxuries for the rich before an adequate output of commodities for the poor is produced. In addition, essential goods and services that are socially desirable may not be produced in sufficient amount under the price system because they are not profit yielding. These goods and services include health, education, defence, lighting, etc. This is the reason why the state provides, in most countries, for what are considered to be basic needs. Furthermore, a free market economy fails to consider all the costs and benefits associated with the production and consumption of commodities. Since they are profit motivated, producers tend to ignore the costs they impose on society as a result of their activities (Begg 1997). In this kind of economy, there is limited competition between firms. A few giant firms may control an industry, in such a case consumer sovereignty is affected; the bargaining position of consumers is weakened considerably while the sellers position is enhances resulting in higher prices and restricted output. Lack of competition and high profits also tend to reduce the incentive for firms to be efficient and resourceful. Due to the imperfection in market mechanism, market economy tends to further increase the disparities between people, that is, those with power and property gain at the expense of those without it. It also, due to its self interested behavior, tends to encourage greed, materialism and the acquisition of power (Sloman 1997). In my opinion, an economy should use the market mechanism to some extent and allow a certain degree of government intervention. Such economies are called mixed economies and all real world economies are a mixture of the two systems. Such a system proves beneficial for all the parties as it gives everyone the freedom to choose and produce while maintaining equality in the economy. 2.1 According to demand and supply analysis, there is an inverse relationship between the price and quantity demanded for a product. When the price for a product is too high, the quantity demanded eventually falls. Likewise, when price is low, quantity demanded increases. The movement along the demand curve is related to price. A change in demand is due to non price factors such as an increase/decrease in number of buyers, changes in tastes and fashion, change in prices of related products etc. There is a direct relationship between the price and quantity supplied for a product. The quantity supplied increases with an increase in the price for a product. Likewise, the quantity supplied decreases with decrease in price for a product. A change in supply is due to non price factors such change in technology, depleting/increasing sources etc. Figure 1: Shift in the Demand curve The demand for cars increased as it is mentioned in the case study, “car makers have been rushing to cut their materials costs amid a demand surge that has pushed up world commodity prices”, and therefore the demand curve shifted from D to D2. Once the demand increases, price rises as well. Therefore, Palladium (the raw material for catalysts) prices increased as a result. Figure 2: Shift in the Supply curve Owing to depleting of sources of Palladium, the supply for it decreased. Moreover, the technology breakthrough decreased the supply for palladium and resulted in an increase of price and decrease in quantity supplied. The lesser the supply, the higher is the price. According to the law of economics, the lesser the supply, the higher the price and when the demand is high the price is also high (Scholasticus K 2010). Mazda and Nissan introduced new methods in which they would decrease the use of Palladium due to increase in their prices. Since this world, the global village, has become too competitive, technological updates are important to survive in the business world. As demand for Palladium decreased, their prices eventually fell in the market. Demand and supply pressures reduced the prices in the market and now these big companies are looking forward for greater low cost procedures. 2.2 Figure 3: Demand for cars Figure 4: Shift in supply in cars Once Nissan and Mazda adopt methods that will reduce their production costs, they can transfer the low costs to the selling price and benefit the customer with economical prices. Moreover, low cost can be converted to higher revenue with greater sales and low costs.. Figure 3 depicts that when price decreases, the demand will increase. This would increase the sales and indirectly the revenue. Figure 4 depicts shifts in the supply curve as production costs would decrease and the car manufacturers would increase their supply. Price will fall and demand would rise for it. In order to compete with Tata, Nissan and Mazda can use other technological breakthroughs. According to some articles, car manufacturers should outsource their production to cheaper countries. However, the quality needs to be thoroughly checked and the “made in Japan” or “made in Germany” label might be altered which could alter exports (PA Consulting Group 2011). Japanese car makers are also intensifying their efforts by using cutting-edge manufacturing technology (Tsutsumino, G 2011). The Yen’s strength has prompted manufacturing jobs in markets with cheaper labour. 3. World financial crises started in the late 2007 and early 2008, due to liquidity crises faced by the American Banks. Since that time manufacturers are trying to cut down their cost so that they can become more competitive in the market. With the shortage of materials such as platinum and palladium, the cost of production of cars has increased. With the global recession car manufacturers are trying to cut down their cost to make their products more competitive in the market. Both Mazda and Nissan developed catalyst to dwindle the cost of using expensive reserves of platinum and palladium to make their market offerings more competitive in the market and enter new emerging markets. As the case indicates that demand of cars is rising but due to shortage of supply of expensive palladium, companies are forced to venture into alternatives that can reduce the cost. Adoption of these cost cutting schemes can greatly help the car industry to lower down their cost of production and therefore increase sales by making more affordable and economical cars. Hence, they can increase their market share worldwide. By cost cutting methods, companies will not only be able to sell their products at a competitive rate but will also lead to increased revenues. References Begg, D. et al., 1997. Economics, fifth edition. Bath Press. Lipsey, R. and Harbury, C., 2003. First principles of economics, second edition. Gopsons Papers Ltd. PA Consulting Group (2011) Available: http://www.paconsulting.com/our-thinking/car-manufacturers-outsource-operations-to-cut-costs/ Last accessed: 28th July, 2011 Scholasticus , K (2010) Demand and Supply analysis Available: http://www.buzzle.com/articles/demand-and-supply-analysis.html Last accessed 28th July, 2011 Sloman, J., 1997. Economics, 3rd ed. Prentice Hall Europe. Tsutsumino, G (2011) Toyota Available: http://www.tunemytoyota.com/forum/showthread.php?t=5521 Last accessed 28th July, 2011 Read More